All That Glitters is Not Taxed. Or is It ?

Originally published on PAOO December 28, 2009.

Given any thought to the tax implications of virtual transactions ? I didn't think so. Do you want some thoughts ? If not stop reading.

The IRS has not issued any guidance on the tax issues on virtual transactions. The issues will become more pressing as time goes on. Some of them are

Income Realization - When do you recognize income from virtual transactions? The simple answer seems to be when receiving some real money. This would be based on the theory that all you’re doing is playing a game and that trading with other players is part of the game. Given Blizzard’s terms of service, there is some merit in this argument. You don’t really own anything. There are however public companies more thinly traded than your WOW gold.

The approved market in Linden dollars trades a few hundred thousand real dollars per day. The price, which is market determined, has been hovering around 250 Linden dollars. Linden Labs plays the role of the central bank having the power to increase or decrease the money supply. It is interested in keeping the rate stable. Bottom line -The exchange rate between dollars and euros is much less stable than that between Lindens and dollars.

The only possible guidance on the realization of transactions within a virtual world are cases about whether casino gamblers recognize income before they cash in their chips (literally). Big help. There aren’t many cases and they go both ways.

As long as virtual items are in demand and companies are careful about controlling the money supply, virtual worlds have the potential to become tax havens.

Recognition – Assuming a virtual world transaction is realized could it avoid recognition because all virtual items, including gold or platinum or linden dollars, are of like-kind to all other virtual items? This entertaining thought experiment would be of limited relevance though since it would only apply to investors, not to hobby players or dealers (except in limited circumstances).

Nexus – Where do virtual world transaction take place? – Yuan, a free lance professional WOW player in China raids several tough dungeons and earns 10,000,000 gold. He sells it to a wholesaler for $10,000 who will sell small lots of 500 gold to recreational players in every state in the United States for them to buy better armor or epic mounts within the game. Where did this happen? Can the US tax Yuan? Can Massachusetts tax the wholesaler who is located in Texas? Can Illinois, where the server is located, tax everybody?

Nature of property - Can you invest your IRA funds in Linden dollars? Why not? Because it is a collectible? Collectibles are by definition tangible.

Transfer Taxes – Even WOW’s strict terms of service allow an account to be shared by a parent and a child. A dedicated player could create many avatars worth thousands of dollars (perhaps with dad buying a little gold now and then). Is the value of those avatars includible in dad’s estate since he paid the subscription fees, while junior did most of the monster killing that built the avatars ?